Many states now allow their residents to
report a liability for state use taxes on their
individual income tax returns. The rules vary by
state, but using the individual income tax return
to report a use tax liability is usually a
convenience and not a requirement. As more states
adopt this approach, practitioners will have to
explain to clients their obligations in reporting
any use tax liability and address the professional
standards for reporting use tax on a state income
tax return.

While this item focuses
solely on the application of the AICPA’s Statements
on Standards for Tax Services (SSTS) to state use
tax reporting, CPAs should be aware of any
applicable state professional standards that might
apply in the states in which their clients file
returns. Note that some states require all CPAs to
follow the SSTS, regardless of whether they are
members of the AICPA.

The SSTS are a set of
enforceable ethical standards that members of the
AICPA must follow when providing tax services to
clients. Under SSTS No. 1, Tax Return
Positions, a CPA is precluded from signing a
state income tax return reporting a use tax
liability unless there is at least a reasonable
basis for the amount of use tax reported on the
return (SSTS No. 1,¶5). Though a
CPA can rely in good faith and without verification
on use tax liability information furnished to him by
the client, the CPA must make reasonable inquiries
if the information or documentation appears to be
incorrect, incomplete, or inconsistent either on its
face or on the basis of facts known to the CPA (SSTS
No. 3, Certain
Procedural Aspects of Preparing Returns,
¶2).

When it is impractical to obtain exact
data, a CPA can also use client estimates when
preparing a tax return reporting use tax if the CPA
believes (based on professional judgment) the use
tax estimates are reasonable in light of the known
facts and circumstances (SSTS No. 4, Use of
Estimates, ¶2). A CPA should inform a
taxpayer promptly when he or she becomes aware of a
taxpayer’s failure to file a required return,
including a use tax return (SSTS No. 6, Knowledge of Error:
Return Preparation and Administrative
Proceedings, ¶4). If an unreported use tax
liability is insignificant, it is not considered an
error for purposes of SSTS No. 6, paragraph 1.

A CPA’s obligations under these standards when
reporting a client’s use tax will depend on (1)
whether the reporting is either optional or
required on the state income tax return and (2)
whether the client will report a use tax liability
on his or her individual income tax return
(regardless of whether the reporting is optional
or required). Even if the taxpayer wishes to
report his or her use tax liability on an income
tax return in optional reporting states, some
states may require the taxpayer to file a separate
use tax return. For example, an Illinois use tax
liability greater than $600 requires the taxpayer
to file Form ST-44, Illinois Use Tax Return.

For states in which the taxpayer is not required to report use tax liability on his or her
income tax return, such as in Illinois and New
York, a CPA may prepare and sign the state income
tax return if the client chooses not to report any
use tax liability on the return (SSTS No. 1, Tax Return Positions, ¶5).If the CPA is unaware of a client’s possible
use tax liability and is not engaged to prepare
any separate use tax return for the client, he or
she is not required under the SSTS to conduct any
due diligence into the client’s possible use tax
liability (SSTS No. 6,¶¶1(c) and 4). If, however, the CPA is aware
that the client has an unreported use tax
liability, the CPA is obligated to inform the
client that he or she should file a separate use
tax return. Notwithstanding a CPA’s obligations
under the SSTS, discussing with the client the
nature of the use tax and his or her options for
complying with use tax obligations provides value
to the client and represents a sound
risk-management practice.

For
states in which the taxpayer is required to
report his or her use tax liability on an income tax
return if not previously reported on a use tax
return, the CPA may prepare and sign the return only
if he or she either obtains the information from the
client necessary to report the correct use tax
liability or obtains the client’s confirmation that
no use tax liability is due. A CPA must exercise due
diligence in determining whether the client has a
reportable use tax liability, but the CPA can rely
on a client’s confirmation that no use tax is due
unless he or she is aware of facts inconsistent with
that confirmation (see SSTS No. 3, Certain Procedural
Aspects of Preparing Returns). If, for
example, a CPA knew his or her client purchased an
automobile out of state and paid no sales tax, he or
she could not rely on the client’s confirmation that
no use tax is due.

If the client will report a use tax liability
on his or her individual income tax return
(whether reporting is optional or required), how
does the CPA navigate the SSTS?

To calculate and report use taxes on an income
tax return, the CPA must be provided by the client
with information regarding purchases to which the
use tax applies.

The CPA can rely in
good faith and without verification on information
furnished to him by the client; however, he or she
must make reasonable inquiries if the information
or documentation appears to be incorrect,
incomplete, or inconsistent either on its face or
on the basis of facts known to him (see SSTS No.
3).

CPAs can also use client estimates of
purchases subject to use tax if it is not
practical to obtain exact data and if they
believe the estimates are reasonable based on
the facts and circumstances known to them (see
SSTS No. 4).

Some
states, including Illinois and New York, will allow
a taxpayer to estimate his or her use tax liability
based on the taxpayer’s adjusted gross income,
although certain restrictions may apply. Illinois
only allows this method if the taxpayer had no
“major purchases” during the tax year. New York will
allow this method provided the taxpayer did not
purchase any items costing $1,000 or more.

Once the amount of the use tax to be recorded on
the income tax return has been determined, the CPA’s
obligations under the SSTS will depend, again, on
whether the reporting is required or optional. If
use tax reporting is required, a CPA
should not prepare or sign the tax return unless he
or she has a good-faith belief that the position has
at least a realistic possibility of being sustained
on its merits if challenged (SSTS No. 1, ¶5(a)).
Notwithstanding this requirement, however, a CPA may
prepare or sign a return that reflects a position if
the CPA concludes that there is a reasonable basis
for the position and the position is adequately
disclosed (SSTS No. 1,¶5(b)).

If use tax reporting on
the income tax return is optional,
professional standards regarding errors and
omissions may come into play. If the use tax is
understated and the amount of that understatement is
significant, the CPA must inform the client of the
correct use tax liability and the potential
consequences of a failure to pay (e.g., tax
penalties and interest) and recommend that the
client file a separate use tax return (see SSTS No.
6). A client’s refusal to report and pay a
significant amount of use tax should cause a CPA to
reevaluate whether to continue representing the
client (SSTS No. 6,¶5).

EditorNotes

Mindy Tyson Cozewith is a director, Washington
National Tax in Atlanta, and Sean Fox is a director,
Washington National Tax in Washington, DC, for
McGladrey & Pullen LLP.

The winners of The Tax Adviser’s 2016 Best Article Award are Edward Schnee, CPA, Ph.D., and W. Eugene Seago, J.D., Ph.D., for their article, “Taxation of Worthless and Abandoned Partnership Interests.”

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